5/05/2012

How will markets react to French and Greece elections?

France will hold a presidential runoff election, while Greece will hold an early parliamentary election on Sunday, May 6, 2012.

In an interview to CNBC-TV18’s Latha Venkatesh, Thomas Corsteg, the economist from Standard Chartered Bank in London, speaks about the possible market reactions to the weekend election results.

Below is the edited transcript of the interview. Also watch the accompanying videos.

Q: If indeed we are going to see Hollande win, how do you expect markets to pan out in the next few weeks? Will they worry about strained relations between France and Germany?

A: You have a lot of concern in the market about these elections. It’s not only the French election on Sunday, you also have elections in Greece; you have regional elections in Germany and also municipal elections in Italy. So, Sunday would be an important day for European politics.

France, opinion polls suggest quite a strong victory by Hollande on Sunday evening. I think this has been factored in by the markets for a lot of time. The key thing is whether Hollande will be able to secure a majority in parliament in the June elections. Opinion polls suggest that it should be the case.

I don’t think that Franco-German relationship will be affected too negatively by those elections. We think that Hollande, if he wins the elections, will be much more pragmatic than the rhetoric suggests. Also, we think that German politics might change after the regional elections. Also, Merkel needs the votes from the socialists, from the SPG in Germany. So, she may move her stance in the coming weeks.

Q: How would you expect the Euro zone economy to pan out in that case? If all that will be permitted is a marginal reduction in perhaps or delay in fiscal targets, are you expecting that the current contraction we have seen in several Euro zone economies will continue for a better part of 2012? When does the Euro zone economy broadly turn the corner?

A: We are quite pessimistic about the euro area in the short-term. We think that the GDP contraction will amplify in the second quarter. So, things will get worse in the coming weeks. The latest survey data supports our view. Infact we think that there is a triple shock to the economy. So, first this fiscal austerity that is weighing on growth, especially in southern European economies, then you have banking sector worries as well weighing on the economy and the third factor is oil price.

Energy prices are at record highs, especially if you look in Euro terms. This is also affecting not only confidence, but also consumer spending. So, this triple shock will result in a continued contraction in Q2 and probably again in Q3.

We then expect a pick-up in GDP. Why? We think sentiments will come back. The European central bank action will have positive results. That it will take time. But ultimately in the longer term we think that austerity measures will continue to weigh on growth. So, we expect a very weak growth for the Euro area for the longer term.

Q: Would you believe that the growth impulses will be largely weak in the coming two quarters? Will that bring down global commodity prices be it copper, be it crude, or be it any other kind of metals?

A: Energy prices, for instance, the global demand is key, not only European demand. Energy markets have been a key player in global commodity markets. So, even though I think that Euro area GDP will contract in Q2 again, I still think that there is a positive momentum at the global level. These could continue to drive commodity prices. Having said, this in terms of oil prices, we don’t a much upside for the coming months.

Q: You spoke about the European Central Bank. Given the circumstances of strained growth as well as the fact that a lot of parliaments are up against the severe austerity demands, do you think we should expect more LTROs from the ECB in the next couple of quarters, maybe one more?

A: We think indeed the European Central Bank will do something in the coming weeks. We rather think that this will in fact be a rate cut. We expect a rate cut in the Q3 to 0.75%. We think this rate cut will come from the fact that GDP will continue to contract in the Q2 and PMI surveys will remain weak. So, this will warrant a rate cut, especially as even Northern Europe is now affected by the slowdown in activity.

Now, turning to LTROs and securities markets programme, yes, we think that if the market’s stress was to increase then we think the ECB would put in place another three-year LTRO. But we are not there yet. We would have to see a financial stress rising much more than what we are currently seeing in the markets.

Q: With the US data coming in relatively weak, do you think the chances now of a quantitative easing go up?

A: Yes, our view is that there will be a QE3 in the coming month in the US. We think that the economy will stay weak in the Q2. So, we don’t expect a pick-up or an acceleration in growth in the Q2.

We rather expect a kind of a slowdown. Why? The underlying momentum in the US economy remains weak, the underlying drivers are very fragile. Consumers are spending, but because they are using their savings, so that’s not sustainable. Also, GDP is affected by inventories. So, you could have a decline in inventories in the Q2.

What we are seeing on the labour market today is that we still have a very fragile economy. It’s not only a question of the labour market, but you still have a very weak housing market and you could have also some vulnerabilities coming from the European debt crisis. This could also affect the US economy. So, yes, we remain very cautious on the US economy.

Q: Finally, if you are expecting quantitative easing from the US and weakness in that economy as well you are expecting rate cuts as well as possibly some kind of LTRO from the ECB as well then where does this leave the euro-dollar, pretty much in this range since both currencies are plagued by weaknesses? Do you just see it around this straddling the 1.30-1.32 mark?

A: Euro against the dollar has been trading in a range for the past few months. But we think that the Euro will break down and will break below 1.30 in the coming weeks. Why? For that there are two reasons, first because we still have this European debt crisis, which is affecting sentiment.

But more importantly GDP will continue to contract. This could affect the bond market. Hence, bond spreads between the US and the European bonds. So, this is a key technical support for the Euro at the moment. We think that this will bring down the Euro from current levels. So, we think that the Euro will weaken to below 1.30 in the coming weeks.